The chairman of the Commodity Futures Trading Commission is clearing a path for proprietary trading firms seeking to act as market-makers in swaps – a business they have been essentially shut out of by the agency’s circuitous rules.
Christopher Giancarlo opened a door to prop firms, many of which are high-frequency trading firms, in a speech at DerivCon on Wednesday (February 27), taking direct aim at the ‘floor trader exemption rule’, which critics argue has long stopped non-banks from getting in on the swaps market action.
“At the end of last year, I asked staff from the Division of Swap Dealer and Intermediary Oversight to develop potential solutions to this problem,” he said. “DSIO staff has informed me that, should they receive a meritorious request, they are inclined to provide appropriately clarificatory no-action relief to assist registered floor traders to rely upon this exclusion.”
Observers translated the chairman’s words as meaning that if a prop firm applied to the CFTC to make markets in swaps, the agency would look past its own rules and allow it to freely provide quotes.
The news was greeted warmly by industry experts and will likely attract interest from firms such as DRW, the TransMarket Group and Virtu Financial that have previously shown a desire to get into the swaps market.
Chris Hehmeyer, chief executive of his eponymous trading and investing firm, was pleased to hear the CFTC take up the subject.
“They are correct to do so,” he said. “The ‘floor trader’ solution is imperfect for all the parties involved and nobody likes it…which means it probably will work!”
Prop firms had begun to sense an opportunity in swaps around the same time the CFTC issued its swap dealer rule in 2012. The rule requires a firm to register as a swap dealer if it enters into more than $8 billion gross notional of certain swaps as a market-maker.
Numerous institutions – mainly banks with hefty market-making activities – signed up as swap dealers. But prop firms, daunted by the financial and operational cost of becoming a swap dealer, did not do so, opting instead to register as floor traders.
The CFTC initially tried to help out the firms. Wanting to expand the number of market-makers, the agency created the ‘floor trader exemption’, which allows firms trading for their own account to act as market-makers for cleared swaps executed on a swap execution facility (Sef), without those trades counting towards the $8 billion de minimis threshold.
But there was a catch. The rule also barred floor traders from some forms of bespoke swaps, where terms beyond price and quantity had been negotiated. That included non-cleared, non-Sef traded swaps, like non-deliverable forwards and rolling spot contracts, which are key markets for many prop firms.
Some, including the Futures Industry Association’s Principal Traders Group (FIA PTG), have said this could mean that if a prop firm relying on the floor trader designation traded as little as one non-cleared swap – even in a non-market-making capacity – it would lose the floor trader exemption and fall foul of the rules.
“The problem that exists today is that the language in the rule was not drafted well,” says an industry expert at a Washington consultancy.
The chairman’s surprise announcement goes in the right direction, the expert said, but he added that the rules governing swap dealers should be rewritten to make the floor trader exemption work more effectively, rather than having the CFTC just ignore its own rule.
“The CFTC needs to go all the way and, by all the way, I mean what they should say is cleared, exchange-traded swaps should be pushed out of the whole de minimis calculation altogether,” he says.
For the CFTC’s part, previous fears that banks might spin off their swap trading entities in order to avoid registering as swap dealers – essentially gaming the floor trader rule – seem to have evaporated. Giancarlo said that bringing in prop firms would improve the swaps market.
“I believe there is support for encouraging increased trading liquidity and competitive prices on Sefs that additional floor traders may provide,” he said.